Bank digital transformation — series 2
After our first article that introduced digital transformation, now we will look at how it’s impacting the banks.
Why is it important?
- New tech disruption in other areas has raised customers’ expectation
- Banking industry hasn’t changed in the last 100 years, hence creating gap between expectation and current offering
- Changes are coming and they have proven to be cause seismic shift in the industry
- Results in incumbent banks to either dramatically transform or be left behind.
What should bank do?
- Apply first principle of design
- 4 possible operating models
- Emerging trends
- Technology trends
- Realize change is coming, it’s dramatic and be serious
- Redefine strategy
Simply put, transformational changes are coming to the financial industry, and if incumbent don’t change, they will be left behind.
New tech disruption in other areas has raised customers’ expectation:
Netlfix changed how we rent movies, and how we watch TV. Apple’s iphone introduced the concept of smartphone and redefined mobile computing. Uber allowed as to get car service on-demand, Amazon made retail click of a button and 2 days delivery. These changes have brought convenience, instant response, and cheaper options. In other words, they have changed customer expectations.
Banking industry hasn’t changed in the last 100 years, hence creating gap between expectation and current offering:
Now if we look at banks, it hasn’t changed in the last 100 years. The concept of branch was actually started over 750 years ago by the oldest bank in the world, Monte Dei Paschi de Sienna.
Changes are coming and they have proven to be cause seismic shift in the industry:
This has created a gap for fintech to disrupt the industry. And the disruption has already occurred. Neobanks across Europe, Alipay and Wechat pay in China, m-pesa in Kenya. To give some reference, m-pesa brought the 30% banked adult population in Kenya to 100% in about 10 years. It took over 120 years to have 30% population banked, but only 10 to reach 100%. Kenya Commercial Bank when partnered with m-pesa, quadrupled their customer in 2 years, given the bank’s history of 124 years. While m-pesa’s success has been nothing short of phenomenal, the real big number is happening in China with Alipay and Wechat pay. With 92% of the payment market in China, they have processed more payment in volume and value than visa and mastercard combined worldwide at $10 trillion annual.
It’s a bit hard to feel the urgency or need to change in the US. US is behind the rest of the world in fintech disruption, but fast or slow, the change IS coming. Because simply put, there is something better (more convenient, cheaper, faster, and same if not better quality).
So change is coming, and it’s a seismic shift. Those banks that are stuck in their old way of legacy systems and branch model will not survive through the next 10 years, possibly shorter.
So, what should banks do?
Apply first principle of design:
Before we go into details, I like to layout some ground methodology. As Brett King pointed out in his Bank 4.0, to really transform itself, banks need to apply first principle of banking, I have explained the concept in my previous article.
But basically, it’s strip down to the most basic utility and built up from there.
The utility of bank is:
1. Store something of value
a) Better than store under my mattress
i. Secure / safe
ii. Easy access
a) Easy, fast, free, acceptability
a) Fast & cheap
With those basic utility, the goal is to offer something better or value add. It should be centered around the following: easier, simpler, faster, cheaper than the current way as I have pointed out in the sub-bullets above.
4 possible operating models:
With that 3 basic utilities and value add in mind, there are 4 new operation model that bank could transform to:
New operation model:
- Digital bank
- Go for a niche.
- Be the infrastructure
Here is my take on the 4 models
a) Allows the bank to just stay in the game. However, it’s important to create value in digital offering. If the digital bank does not offer any value add to existing offering, it will fail. Case in point: Finn from Chase.
2. Focus on niche / specific area:
a) The bank should assess whether the bank has competitive advantage in the specific area. If does, then could work.
b) One of the caution is that this model may need to rely on traffic from platforms
c) Acorn on WM, Robinhood on trading, Betterment on Robo-advisor
3. Pipe — open banking — possible, but don’t need much.
a) A model where provides API or the plumbing for other financial institutions.
b) This model could work, but again likely to be commoditized. So, may be very competitive
c) Ex: Plaid
a) The one stop shop model. Platform provides all of clients financial need in one place. A winning platform should leverage its scale effect to combine the best products / offering in every category.
b) I would encourage those who can to go for this model. As we have seen the emergence of super apps and their success. It’s not hard to foresee the “Amazon of finance” emerge in the next decade. They have already emerged in China and Kenya.
It’s important for banks to access its capabilities, DNA, and figure out the model most suitable.
We see 4 emerging trends as we embark on digital journey. The first 2 have already occurred. As the industry goes through different stages of digital transformation, we will start to see trends 3 and 4
1. Users are moving to digital. Shift in traditional bank distribution from branch to digital (computer, mobile, embedded). Banks are playing catch up
i. Anticipate what kind of product the customer may need. Use data analytics
ii. Convert inquiries into sales
b) Data analytics to determine & npv to determine physical footprint & the type/format of branch
The important takeaway here is data. How banks collect and use the data will be critical in the future
2. User experience
a) Focus on journey and sub-journey.
b) Change the way you engage with customers
i. Banks need to deploy tools and empower employees to play a more consultative role to customers. Ex：Empower wealth managers with tools that provide recommendations.
c) Personalize & real time offering
i. Like location based real time discounts
As I have pointed out in my previous article, it’s the first area banks tackle to get quick wins in the digital transformation journey. However, it’s important to note here that the difference between digital capabilities vs. true user experience
3. scale effect
a) branding effect matters
b) economy of scale will be more visible as moves to digital.
We often see scale effect as services becomes digital & commoditized. It’s inevitable, and important for small and medium banks to re-access their strategy.
4. Unbundling and re-bundling effect in retail banks
a) We are seeing customers with separate accounts for different financial purpose.
b) In the future, it likely will consolidate into one
i. Gateway app
ii. Economy of scale: Amazon
c) Bank can stand out because it has transactional data
d) It’s about how banks can leverage its insights into customers to provide superior products and services that will stand out. Note: the product & services does not have to be a bank service.
e) Ex: one Northern Europe bank developed mobile app with house search (mortgage), help set up new home (for example, utilities, appliances, and renovation), budgeting..etc.
I think we have already started to see the unbundling effect (robinhood with stock trading, acorn with investment management, chime for digital bank..etc). This is symptom of new industry in its early phase. As new entrants typically start by focusing on a niche. But as the industry progress, it’s not hard to foresee platform emerges to offer competitive products all in one place. Because for the simple reason that it’s just more convenient and doesn’t make sense for user to use so many different apps.
An interesting analogy that I read from McKinsey’s report on digital strategy, that compared the unbundling and bundling to the music industry:
The bundling and unbundling can be best illustrated using the music industry analogy.
The history of music industry may provide a model for how things will go in the banking industry. Music used to be sold in album in stores. In the early 2000, digital distribution, especially iTunes, radically reduced distribution costs. Consumers can now “unbundle” and purchased only the track they like. Not surprisingly, many stores went out of business. Then playlists emerged, spotify, apple…
The success of these platforms is based on their ability to create highly personalized bundles based on consumer needs and preferences, and a superior interface without the friction of purchasing tracks individually.
In addition to the following trends, I think it’s also important for banks to pay attention to the following technologies: AI, data analytics, and embedded banking.
We have already seen the use of AI in banking from chatbot to fraud detection. And some of the more innovative banks have already integrated into wearable or home voice device like Alexa. In the near future, it will be more convenient. We won’t need any plastic or even need to apply for a loan. Our future financial advisor will automatically know that we are about to make a purchase, and if we are short, automatically apply for a loan before we get to the checkout.
My final thoughts
1. Realize that change is coming, and it’s going to redefine the industry
2. Define a strategy that you can win
a) Define future state, assess the current capabilities and figure out what’s the best way to get there
b) Look into the model that makes the most sense or create your own model. Just remember, first principle of design, create value, and be practical
c) Example: it’s not very practical for a small credit union to want to be the future amazon of finance. Perhaps should focus on its local market, and figure out how to create localized value for most relevant to its customers.
As Brett King pointed out in Bank 4.0, banking everywhere, but never at a bank. He has got it right on Bank 2.0 and 3.0